Your Primer for the Coming Buy Signal

I’m going to take a break this time around from writing about my upcoming wedding to get back to some market-related lessons. As I’ve written in recent weeks, there are ample signs that the market’s bear phase is close to (or has already reached) its end point.

I won’t rehash all the signs here (double-bottom in the indexes, new lows divergence, Bear Stearns bad news, etc.). Instead, I want to take a few paragraphs to dispel a common belief among most investors–that you must get in as quickly as possible to make big money in a bull market. The earlier, the better!

It’s not a surprise most people believe this. After all, in just about any competitive activity, the faster you are on the draw, the better your results. The fastest 40-yard dash time helps a wide receiver get drafted higher, while a quicker swing at the plate makes you a better hitter and a quick release allows a quarterback to avoid sacks. “Speed kills” is now a well accepted term in the world of sports.

But in the market, remember, patience is a virtue. Most investors believe that the closer they buy near a market bottom, the more money they’ll make. If you’re investing in an index fund, that’s true-you’ll make an extra couple of percent if you correctly jump the gun when buying the S&P 500. But considering the risk that you might buy at a false bottom, we don’t think the risk is worth the reward.

Take Time to Jump Back In

In terms of individual stocks, we’ve actually found that the most powerful leaders of a bull advance usually come off the launching pad a few weeks after the bottom. In fact, many leaders have begun their advances two to four weeks after our buy signals (which themselves usually come a couple of weeks after the bottom). I can tell you from my own experience that my biggest winners the past few years have been purchased at least a week or two after our buy signal.

My analysis also shows that my first one or two purchases following a buy signal have, on balance, lost money in recent years. None were huge losers, but the majority just didn’t get going, and if they did, their advances were far from mighty. Right now, despite some encouraging behavior from the overall market, I’m seeing almost zero top-notch growth stocks (or commodity stocks, for that matter) that are breaking out of nice consolidations. That’s a good reason to take things slowly.

Now, I know what you read online and hear on TV: You have to get into such-and-such stock NOW … don’t miss the boat … if you’re not in the market during its best few days of the year, your returns will be average … and so on. That’s just Wall Street gibberish, based on opinion or a twisting of numbers, as opposed to knowing how the market really works.

Our studies show that practicing patience will help improve your batting average, and will keep your funds free to invest in what will turn out to be the best stocks. So the moral of the story is: Earlier is not always better in the stock market. Remember that as the market tries to build a sustainable bottom.

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Minimizing Mistakes

Another reason to remain patient has to do with the fact that, in the market, a huge part of your overall success depends on minimizing mistakes–i.e., how you play defense. As written above, most media preach the opportunity cost of being out the market. Missing out on a big winner, it’s widely believed, is the worst investing sin.

Now, don’t get me wrong. When the market is in full bull mode, I can be as aggressive as they come. Any subscriber to our Cabot Market Letter or Cabot Top Ten Report knows I have no hesitancy about getting into fast-moving stocks in a good market.

But when looking out over a number of years, I know that limiting mistakes is even more important than finding that elusive big winner. The reason is simple: Big winners are relatively rare (some years you find a few, others, you’re lucky to grab hold of one), but even the best investors buy plenty of stocks that go nowhere. So there’s more opportunity for those losers to eat away at your capital!

(Incidentally, that is one reason why the market is so hard on investors’ psyche; unless you’re a daytrader, most people are only going to uncover one big winner for every 10, 15 or 20 stocks they buy. Such long odds can be mentally trying.)

As an example, consider an investor, whose yearly returns were as follows: +30%, +25%, +25%, +10% and -20%. So he had three very good years, one average year, and just one poor year.

Now look at another investor’s returns: +25%, +20%, +15%, +5% and 0%. Four of the five years, the first investor had superior returns … but the second investor made more money! It was close, 81% total gain versus 79% for the first fellow. As it turns out, that single -20% year damaged the results, even though it was combined with a bunch of stellar returns.

My point isn’t that you should always be super-conservative and be afraid to lose money. My point is that it’s not always about beating the market or having your money working for you. Much of the time, the intelligent investors are basically doing nothing, waiting for the right environment to take decisive action.

In his book, “How to Trade in Stocks,” Jesse Livermore said there are just a handful of times each year when he would be active-near the intermediate-term turning points in the market. Other than that, he let his account sit idle, making sure he didn’t lose money, and preparing for the big swing when the market changed course.

Just something to think about while the current market sloshes this way and that.

If you are remaining patient, you should be building a watch list of potential winners. The three I’m watching the closest are …

Gafisa (GFA), a Brazilian homebuilder that’s taking advantage of a still-strong economy, more lenient mortgage terms and pent-up demand for dwellings (especially lower-end homes) to post extremely fast growth. In fact, Gafisa is really one of the only “new” stocks that’s posting rapid sales (up 88% in the last quarter) and earnings (up 400%) growth. Thus, if this market gets going, I’m thinking GFA has a chance to put on a very good show. A big breakout above 43 would be highly bullish.

I continue to stalk Visa (V), another new stock. It’s too soon to buy it, but considering that many big banks (including JP Morgan) own stakes, and given the superb business model, I believe it could be a big-cap leader of a new bull market. I’m guessing hundreds of mutual funds are already busy accumulating stakes.

I’m also very intrigued (and encouraged) by the action of First Solar (FSLR), which was probably last year’s #1 glamour stock. History tells us the big winners of one year usually suffer the next, but FSLR’s unbelievable growth (revenues were up nearly 300% each of the past two quarters) has helped the stock remain in a base-building phase. More work needs to be done, but I’m very interested to see how the stock reacts to its first-quarter earnings release, due in a few weeks.

Hopefully there will be literally dozens of winners to choose from when the market ramps higher, but for now, these three are worth keeping near the top of your watch list.

All the best,

Mike Cintolo

Editors Note: Michael Cintolo is Cabot’s Vice President of Investments and editor of Cabot Market Letter, the company’s flagship Letter. Since the start of 2007-a time when the market has experienced many ups and many downs-Mike’s time-tested stock selection and market timing indicators has helped the Market Letter’s Model Portfolio outperform the S&P 500 and Nasdaq by 30%. He does this by concentrating his subscribers on the market’s very best leading stocks (First Solar, Crocs and Intuitive Surgical were three of his winners last year), and by telling subscribers when to sell. (He’s advised being in at least 50% in cash since mid-November of last year.) If you’d like to boost your results, give the Cabot Market Letter a try at this special introductory rate. 

http://www.cabot.net/info/cml/cmlim01.aspx?source=wc01

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